Director's DLA draw and Tax Credits

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I have a client with a small company, floated 8+ years ago with his own capital. His wife does the modest bookkeeping for £480 per year. They have 2 children under 16. He's still drawing back his original DLA (though nearly expired now) and has had no salary or divis to date. He also has a small sole trade (completely independent) which has profits of around £2k to £3k per year, but reducing in favour of the Company trade. How does he stand for Tax Credits with regard to the 'hours worked' requirement of "24 hours between you"? The wifes wages equate to approx 1.5 hrs per week on min wage. He genuinely works a varying 30 - 40 hour week over the two businesses but, if you go by a minimum wage prorata, his sole trade is equivalent to (max) only 9.5 hours. Since the balance of their financial needs is taken from the Company, drawn back from his DLA, there's no payslip proof of the other 16'ish hours worked.

Does it matter that we can't support the 'hours worked' declaration? We don't want to mess up the renewal. What's spooked me is looking at the HMRC guidance where they say that "in families with an income of £9485 a year or more, at least one adult is assumed to be working 30 or more hours per week (consistent with minimum adult wage rate of £6.08)..". If that's their assumption, will HMRC accept an hours worked declaration of say, 35 hours, when the total income for him is only equivalent to 9 or 10 hours at minimun wage?! We have to handle the renewal this time because the wife has been spooked by HMRC rudeness previously, and I'm just not sure of the rules in this. I cannot see DLA's mentioned in the Tax Credits guidance but assume/hope that DLA drawings are NOT to be treated as 'notional income'!! See page 22 of the 2012-13 guidance.

Thanks, good observation. Actually, the Company only moved from loss into profit with its June-09 results and has been soaking up b/fwd losses since. The losses were finally used up completely in the Jun-11 accounts. He is drawing salary in 2012/13. And, yes, the business is cash-based.

I think it is better to stay away from salary if the income is at a level of only a few thousand pounds a year, and tax credits are being claimed. If dividends later start to be taken, then dividends should be done only after a salary has been done, as dividends do not get any tax relief in the company, and equally affect tax credits as does salary.

Tax credits at this level of income are very high, as much as £12,000 for 3 children, or around £8,000 for 2 children (from memory). Tax credits run at around slightly less than half the level of income at this level of income (from memory).

Therefore an increase in salary to £5,000 from zero (assuming £3k other income) could lose you £2,500 per year in tax credits. Corporation tax is at 20% for a small company, so although corporation tax is lowered, tax credit losses would be far higher. Keep the income low.

If using the "income disregard" on tax credits, you could do a basic salary every other year if you are careful and know what you are doing, without affecting tax credits. This way, you can get some salary and decrease the corporation tax, while not affecting tax credits adversely.

Regarding hours vs national minimum wage: so long as there is no employment contract, the numbers of hours worked is the numbers of hours worked. As a director without an employment contract he is an officer of the company, and not an employee. Regarding the wife, if she was company secretary/director, therefore an officer of the company, she also could have much higher hours worked than the payment suggests. However, you shouldn't be making up the hours to inflate the tax credit award!

Income of anything up to £6,420 is disregarded for tax credit purposes, so the tax credit award for a family with income of £0 will be exactly the same as a family with income of £6,420. Tax credits are then reduced by 41% of income over the £6,420.

I too cannot understand why a salary of just below the tax-free allowance hasn't been paid. There would be no tax payable by the director, no effect on their tax credits award, count as a qualifying year for state pension purposes, allow entitlement to SSP etc, and, if the company was making a loss a salary would increase that loss, which can be carried forward and set off against future profits.

But the income is not zero, the original poster says that the client in question has a few thousand pounds sole trader income each year, therefore, the £6,420 salary should be restricted by the estimated sole trader income? If the salary is done at the end of the tax year when the sole trader income is presumably known then the salary could be finalsed?

What I was trying to say in my original post was that a personal allowance salary for all directors isn't always the best policy if tax credits are involved. The first responder suggested that an NI free salary should be given, but this is higher than the £6,420 tax credit limit you mention (of hand I think it was £7,072 last year), and hasn't taken into consideration his other income. Therefore a salary should only be around the £3.5k mark right?

I have read many times that to be eligible for the working tax credit element, a director must have a contract of employment and therefore work the required number of hours. If they have a contract of employment, they must be paid the minimum wage. Without a contract of employment they are not actually working.

Has this been overlooked by the above posts or have I been fed incorrect information in the past?

However, I suppose if the client is also self emloyed, he could argue that he does work the required number of hours in a self employed capacity. Not sure if this would stack up for only a few thousand pounds income though, and as you say it is only 9.5 hours in reality.

I think I will continue to advise my director clients to have a contract of employment in place all the same going forward though, especially where they are making use of their allowance. At least then there can be no argument over the hours worked.

You have to weigh up the merits of each individual on a case by case basis. If the client wants to claim WTC then I would advise them to have a contract of employment in place even if this means they have to be paid the minimum wage and wind up paying themselves more than the personal allowance.